Book Depreciation

Lecture No. 33
Chapter 9
Contemporary Engineering Economics
Copyright 2006
Contemporary Engineering
Economics, 4th edition, 2007

Book Depreciation
Methods

Purpose: Used to report net income to

stockholders/investors

Types of Depreciation Methods:

Straight-Line Method
Declining Balance Method
Unit Production Method

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Engineering Economics,

Straight Line (SL) Method

Principle
A fixed asset as providing its service in a uniform
fashion over its life
Formula
Annual Depreciation
Dn = (I S) / N, and constant for all n.
Book Value
Bn = I n (D)
where I = cost basis
S = Salvage value
N = depreciable life
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Engineering Economics,

Example 9.3 Straight-Line Method

I = $10,000
N = 5 Years
S = $2,000
D = (I - S)/N

n
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Engineering Economics,

n
1
2
3
4
5

Dn
1,600
1,600
1,600
1,600
1,600

Bn
8,400
6,800
5,200
3,600
2,000

Declining Balance Method

Principle:

A fixed asset as providing its service in a

decreasing fashion
Formula
Annual Depreciation

Dn Bn 1 (1 ) n 1
Book Value
B (1 ) n

where 0 << 2(1/N)

Note: if is chosen to be the upper bound, = 2(1/N),

we call it a 200% DB or double declining balance (DDB) method .
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Engineering Economics,

Example 9.4 Declining Balance Method

I = $10,000
N = 5 years
S = $778
Dn = Bn 1
= I (1 - n 1
Bn I (1 ) n

n
0
1
2
3
4
5
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Engineering Economics,

Dn
$4,000
2,400
1,440
864
518

Bn
$10,000
6,000
3,600
2,160
1,296
778

Example 9.5 DB Switching to SL

Asset: Invoice Price

Freight
Installation
Depreciation Base
Salvage Value
Depreciation
Depreciable life

$9,000
500
500
$10,000
0
200% DB
5 years

SL Dep. Rate = 1/5

(DDB rate) = (200%) (SL rate)
= 0.40
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Engineering Economics,

Adjustments to the DB
Method
Switch from DB to SL after n

No further depreciation
allowances are available
after n

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Engineering Economics,

Case 1: S = 0
(a) Without switching
n
1
2
3
4
5

Depreciation
10,000(0.4) = 4,000
6,000(0.4) = 2,400
3,600(0.4) = 1,440
2,160(0.4) = 864
1,296(0.4) = 518

(b) With switching to SL

Book
Value
$6,000
3,600
2,160
1,296
778

Depreciation

1
2
3
4
5

4,000
6,000/4 = 1,500 < 2,400
3,600/3 = 1,200 < 1,440
2,160/2 = 1,080 > 864
1,080/1 = 1,080 > 518

Book
Value
$6,000
3,600
2,160
1,080
0

Note: Without switching, we have not depreciated the entire

cost of the asset and thus have not taken full advantage of
depreciations tax deferring benefits.
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Engineering Economics,

Case 2: S = $2,000
End of
Year

Depreciation

Book Value

0.4($10,000) = $4,000

$10,000 - $4,000 = $6,000

0.4(6,000) = 2,400

6,000 2,400 = 3,600

0.4(3,600) = 1,440

3,600 1,440 = 2,160

0.4(2,160) = 864 > 160

2,60 160 = 2,000

2,000 0 = 2,000

Note: Tax law does not permit us to depreciate assets below

their salvage values.
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Engineering Economics,

Units-of-Production
Method
Principle
Service units will be consumed in a non
time-phased fashion
Formula
Annual Depreciation
Dn = Service units consumed for year (I - S)
total service units

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Engineering Economics,

Example 9.7 Units-ofProduction

Given: I = $55,000, S = $5,000, Total service

units = 250,000 miles, usage for this year =
30,000 miles
Solution:

30, 000
Dep
($55, 000 $5, 000)
250, 000

($50, 000)
25
$6, 000
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Engineering Economics,